Wednesday, December 16, 2009

We Own Citibank from Where?

A colleague once asked me to come with him to pitch a client in Abu Dhabi. I was working in the Gulf and had had some recent successes so he wanted me along to demonstrate our commitment to the region. We drove the hour or so from Dubai to Abu Dhabi, met the friend and pitched our idea. The guy let us talk about it for about forty five minutes then asked us some pertinent questions and then thanked us. “So how about it?” My colleague asked.

“Well, it looks like a great opportunity but I don’t think we can swing it.” Says the guy.
“Why not?” We ask.
“Well, you’re not really on our list of preferred banks.” He says. Keep in mind we were the largest bank in one of the largest countries in Europe. My colleague was undaunted.
“Surely this transaction can get us onto that list.” He says.
“Well, not exactly. We have a list of banks waiting to get on our preferred list. You’re not on that list. Then we have a list of banks waiting to get on the list of banks waiting to get on our preferred bank list. You’re not on that list either. But after today I can put you on the list to get on the list to get on the list.”

It was humiliating. We were being kept behind some kind of investment banking velvet rope. We weren’t on the list, or even the waiting list to get on the waiting list. I felt like I did when I waited in line for an hour and a half at the Ministry of Sound only to be turned away for not wearing “glamorous clubwear.” I remember trying to decide what would be more embarrassing: getting turned out of the Ministry of Sound or actually wearing what passed as “glamorous clubwear” in 1995.

The name of the client was ADIA the Sovereign Wealth Fund (SWF) of Abu Dhabi. At the time they had something like $800 billion under management which made them one of the largest investors in the world. SWFs were created by the Arab states to manage their current account surpluses and to put something away for a rainy day. They are generally competently managed and usually have multiple advisors that they play against each other in order to sift the best ideas.

As you can see from our story financial intermediaries are lined up around the block pitching investment ideas to them because a few words in the right key could put you in touch with a truly massive amount of money. With $800 billion there is almost nothing you can’t buy and transactions that are of massive importance to the seller are a trivial proportion of the total assets of ADIA.

And so it was that in the fall of 2007 the worlds banks converged on ADIA seeking to recapitalize their firms after having the stuffing knocked out of them during the subprime crisis that began in that summer. There were many deals done that year with sovereign wealth funds one of them was done between Citibank and ADIA.

In the deal ADIA put up $7.5 billion and got preferred shares that would pay an 11% coupon until 2010 at which point the preferred shares would convert to common equity at a conversion ratio that would imply a price of $30-$37 dollars. Citibank shares closed today at $3.45. Looks like someone is going to be taking a mark to market P&L hit when that conversion happens. A big one. Like $6.7 billion dollars big.

Before one bursts out laughing it is important to remember when this deal was made. It was made in November of 2007. At the time the severity of the subprime crisis was just coming to light and not fully appreciated. Nonetheless Citibank shares had been cut in half while the wider market was only down a few percent from all time highs set in October. So ADIA was getting a chance to get an 11% coupon from what at the time was a AA rated entity and buy the shares of the largest bank in America at 50% discount.

Reading about the deal at the time and wondering what must be going on at Citibank that a AA rated bank holding company was paying 11% for funds. Remember a year later in the midst of the financial crisis Warren Buffet only got 10% on his Goldman preferred AFTER the Lehman collapse. I remember thinking either Citibank management was panicking or did not deserve its AA rating but in either case ADIA seemed to be getting a great deal. It is also possible that the fact that their stake in Citibank would give them a larger stake in the firm the most famous Arab investor who practically made his name in it may also have influenced them.

The rest, as they say, is history. Citibank share have dropped from $30 to $3 with quite a lot of excitement along the way and now ADIA is looking at a 90% loss. Well someone at ADIA seems to have had the idea that maybe history might be negotiable. It seems that someone from ADIA called up Citibank and asked if it might be possible to change the conversion ratio so that ADIA’s effective purchase price would be something more in line with where the stock was today.

It probably seemed reasonable to them. They are the largest investor in the world. Citibank has a thriving business in the Emirates and probably a lot of Al Nahyan money in its private bank. It had been courting the Arab world since it fled Saudi Arabia in haste in 2001 they probably felt the relationship factors worked in their favour. It might have also been embarrassing that lately some other SWFs had sold their Citibank shares at a profit partially because they got in later and partially because they insisted on structures that protected their downside risk. Also this sort of negotiation is not uncommon between big financial players when one side has experienced a large unexpected loss. Sometimes there is a little give and take in order to preserve a longer term relationship.

It might have done them some good to take a break from obsessing about the collapse of Dubai and read an American newspaper or two. Or to check who they would be joining on the shareholder register of Citibank. They would have noticed that the last thing on the minds of the people who run Citibank is their relationship with ADIA. Like most people in the financial services industry, including myself, their primary concern is with their bonuses. Now the trouble with working at Citibank right now is that there is a guy in Washington who decides what your bonus is without reference to the shareholders. The US Treasury is also the largest single shareholder of Citibank. The trouble is that both the guy in Washington and the Treasury work for this group of people known as “the voters.” The trouble with “the voters” is that they, on average, make about $45,000 per year which is damn good for a per capita GDP figure but is pretty light as a bonus. And these characters, “the voters” seem to get a lot of satisfaction out of lightening the Citibank bonus pool.

As a result the number one priority for Citibank executives is to get rid of their relationship with “the voters.” This is a major problem for the guys who run Citibank. In order to pay back the TARP money, they have to raise equity and sell shares. The trouble is, who wants to buy shares of something they know the government owns a ton of and wants to sell? Tricky. So Citibank was in the middle of negotiating all this with the appointed representative of “the voters.” When they got their call to renegotiate from ADIA. ADIA probably wanted this to be done quietly but that isn't what Citibank wanted. ADIA played into the hands of the Citibank executives because now they could tell the government that they had ADIA threatening to back out of the deal and to do it publicly so the government should back away from its’ pledge to sell.

Indeed as of the close of business today “the voters” are reconsidering thier plan to sell their shares and Citibank has sold equity and raised the money.

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